My good friend Chris Skinner noted that the amount that banks spend on technology is vastly greater than the amount that fintechs spend on it but the incumbents don’t seem to get much innovation for it. He is characteristically accurate in observing that this is partly due to the fact that much of their spending doesn’t go anywhere near new products of services, but does this mean that bank technology spending could be redirected to more innovative efforts?
I don’t think technology-led innovation makes much sense for banks, and I think that their strategies should recognise that and focus instead on geting ahead of the inevitable structural change that is coming to the sector.
I was once invited to a board “away day” for a large European bank that was reviewing its IT spending. It’s not appropriate to say which bank, but the CTO was a very impressive person and I thought that his analysis of the problems that the bank was facing was illuminating. Out of an IT budget of approximately €1 billion, approximately €800m went on, as Chris would say, “keeping the lights on”. Much of the infrastructure is old and increasingly expensive to maintain, so that figure continues to increase. Meanwhile, of the €200m in available new technology spend, around €150m was committed to regulatory and compliance systems. So only €50m was available for new products and services (mostly catch-up) and my impression was that only a fraction of that, perhaps €5m, was available for “skunk works”.
In summary, with only €5m available to be spent it made no sense for the bank to try to compete with fintechs. The rational strategy, and in fact the one that they had adopted, was to allocate the skunk works money to building partnerships with fintechs (and in this particular case, regtechs) that might deliver transformation that would more directly affect the bottom line. I remember thinking at the time that for most banks, this was the only strategy that made sense, but that it was also fraught with danger. In short, as we shift to a world of embedded finance and open banking, the role for the bank becomes restricted.
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To see what I mean, consider the simple example of Wise (Transferwise, as was). As an SME myself, I use Wise to handle payments in Dollars, Euros, Aussie Dollars and so on. I couldn’t care less which banks actually provide the underlying currency accounts and I never access them or their services: I use the Wise app to move money between the accounts and use the Wise debit card to pay in multiple currencies when necessary and, I have to say, it has always worked perfectly for me. So is the best strategy for a bank to try to offer me multicurrency accounts (the strategy that has just been announced by HSBC with their Global Wallet product in the US) or to offer a superb API to Wise?
Now, this isn’t an idle question. Remember the discussion about banks and payments from my previous Forbes column? I pointed out that Jamie Dimon had singled out payments as a specific hill for banks to die on because payments account for the overwhelming majority of interactions between a bank and its customers and therefore customer data. If bank lose the payments franchise to fintechs (or techfins) and are unable to execute strategies (eg, digital identity) that keep them in the transaction loop, then they have to make a strategic change.
Mr. Dimon knows a lot more than I do about banking, and is obviously correct. The impending disintermediation is not only about payments and payments data. A key impact of new technology must be that the role of banks as intermediaries is reduced as fintechs step in, so all kinds of financial services that were traditionally the remit of retail banks will become embedded inside other services. Players such as Galileo and Marqueta can deliver “bank in box” services into this market with speed and flexibility. Stripe (which is becoming the 600-pound gorilla in this space), for example, has launched Stripe Treasury (with partners including Goldman Sachs GS and Citibank) through which customers can create bank accounts and access ACH.
Similarly, look at what Modulr is doing in the UK. As one of the UK fintechs that have taken advantage of the Bank of England’s forward-looking policies it is a directly connected BACS (the clearing system) participant and as a direct member of the Faster Payments scheme (FPS) with a central bank settlement account. The company, which recently secured new investment from FIS Ventures, is providing a Payments-as-a-Service (PasS) api platform for software companies that deliver services to primary small and medium-sized businesses.
I wonder if the users of Stripe Treasury or Revolut (which uses Modulr) will care which banks sit behind the accounts that they use any more than I care which banks sit behind my Wise accounts?Banks Don’t Matter, What About Bank Accounts?
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Banks Don’t Matter? What About Bank Accounts?
Is this where we are going then? Techfins doing the distribution (getting the baked beans to the consumers), fintechs doing the packaging (putting the baked beans in the tins and adding brand promise) and banks doing the manufacturing (all the baked beans are made in the same few factories anyway) sounds like a pretty reasonable vision of the future to me. I can well imagine Google GOOG Suite offering me a company account that is actually provided by a bank that I will never interact with and never care about because all of the baked beans are basically the same.
Things might change even more radically though. Never mind bank brands and branches, maybe there’s no need for a bank at all. Tom Noyes said “imagine a world where bank accounts don’t matter” and went on to point out that the emerging fintech giants (eg, Shopify and PayPal PYPL in the USA) will enthusiastically adopt central bank digital currency (which, remember, carries no credit risk) to bypass not only the traditional payments intermediaries but the traditional financial system as a whole. They will use the new digital cash technologies to transfer payments directly from the consumers’ digital wallets to the merchants’ digital wallets with no ACH, network or settlement system in sight.
The reality is that Square SQ , Stripe, Amazon AMZN , PayPal and Shopify are in an arms race right now, using partnerships (eg, Square and Google) and acquisitions (eg, PayPal and Honey) to capture merchants and build their defences against the banks and their lending businesses. In a recent (excellent) piece on this here in Forbes, Ron Shevlin recommends that banks fight back against the masses forces of embedded finance by capturing adjacencies, but I wonder if it is really viable for banks to challenge on the distribution side. Maybe it’s best to provide the best loan API to specialists who services merchants rather than the best merchant service?
What are the implications of this? The Centre for the Study of Financial Innovation (CSFI) is a London-based future of finance think-tank (of which I am proud to be a member of the governing council). In a CSFI-hosted discussion on the architecture of the international financial system last year with Charles Taylor (Deputy Comptroller at the OCC from 2011 to 2016, during which time he also chaired the Basel Committee’s Standards Implementation Group) he said that
Banks will have to shift gears to become more capital markets institutions and less intermediators… you may end up with fewer of them.
I interpret these wise and well-informed words to mean that we are going to see a consolidation on the manufacturing side of financial services. In which case is it reasonable to ask that whether banks should spend any of their IT budget on new services at all? It is a brave strategic decision for banks to spend money to compete on new services rather than invest R&D in the more efficient manufacturing of more cost-effective, reliable and safe credit products (which regulators will ensure remain in the domain of strictly-regulated financial institutions) and I think that the days of “innovation labs” must be numbered.
Far better to focus on delivering the AIs and APIs, digital identities and credentials that are the core of all online business (not only banking) in the future.